DraftKings Inc (DKNG) said in its latest earnings release on Feb. 15 that it expects to make between $310 and $410 million in free cash flow (FCF) this year. DKNG stock's value could be worth at least 50% more if it occurs.
The reason is simple. This is completely unexpected and if it occurs it means that the company's FCF will be close to 8% of its revenue. That is because analysts forecast revenue of $4.71 billion this year. So the midpoint estimate from the company of $360 million is equal to 7.64% of $4.71 billion. Moreover, if the upper end of $410 million in FCF occurs, that implies a FCF margin of 8.70%.
As a result, DKNG stock has been rising and closed up to its highest price in 6 months at $44.57 on Friday, Feb. 16. But it could still be worth substantially more, as much as 50% more. Here's why.
Implications of Positive FCF on DKNG Stock
DraftKings' free cash flow has huge implications for the DKNG stock going forward. For example, in 2025 revenue is forecast to rise by 20% to $5.65 billion. So, using an 8.0% FCF margin implies that FCF could reach at least $452 million. And using an 8.7% FCF margin estimate brings this to $491.6 million
Using a 1.5% FCF yield metric with the $360 million midpoint estimate for this year implies a market cap of $24 billion (i.e., $360m/0.015 = $24,000 million). That is 13.7% higher than today's market cap of $21.1 billion.
Moreover, if we apply this metric to the upper end of $491.6 million in FCF for next year implies a market cap of $32.8 billion (i.e., $491.8m/0.015=$32,773m). That is 55% higher than today's market cap.
So you can see that it's possible that sometime in the next 12 months analysts could estimate DKING stock's value would be at least 50% higher. That gives it a target price of $66.86 per share (i.e., 1.50 x $44.57 price today).
One way existing shareholders can play this is to sell short out-of-the-money (OTM) put options in nearby expiry periods. That way they can gain extra income while they wait for DKNG stock to rise.
Shorting DKNG Put Options for Income
The premiums for DraftKings put options are very elevated. That provides a good opportunity for short sellers of OTM puts in near-term expiration periods.
For example, look at the March 8 expiry period, which is three weeks away. It shows that the $41.00 strike price, which is 8% below today's price, has bid side price of 43 cents. That equates to 1.05% of the strike price. So the short seller of these puts can make 1.05% with just 3 weeks until expiration.
An investor who secures $4,100 in cash and/or margin with their brokerage firm can enter an order to “Sell to Open” 1 put contract at this strike price. The account will then receive $43.00. Alternatively, they could secure $20,500 with the brokerage firm and then sell short 5 put contracts at $41.00 for expiration on March 8. The account will then receive $215.00.
In both cases, this works out to an immediate yield of 1.05%. If repeated 4 times during a quarter that works out to $860 on an investment of $20,500. That is an expected return of 4.195% in just 90 days.
The bottom line is that this is a good way to play this opportunity with DKNG stock. Given the potential upside over the next year, it makes sense to hold the stock and short OTM puts both for income and to help protect any potential downside action in the stock. That is because the extra income generated acts as a hedge against any downdraft in the price and the resulting unrealized losses.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
